Posted by The Editor

What would happen in a worst case scenario and Spain were to return to the Peseta? Is this even likely?

[Editor’s note: we very seldom offer guest posts, but given the tension caused by the financial crisis and resulting doubt about the state of the Euro currency in Spain, we thought we’d offer some thoughts from currency specialist Peter Lavelle from Pure FX. Leave a comment below with your own thoughts about the possibility of a Euro collapse or let us know if you think we should get back to doing all of our own research and reporting!]

These days it seems as though not a day goes by without a new bleak report from the Eurozone. Right now, we’re contending with the partial nationalisation of Bankia in Spain, where the government has claimed a 45.0% stake, as well as the arrival to prominence in Greece of several anti-Euro parties.

But what might happen if the worst were to pass: the collapse of the Euro and a return to the peseta? The following are what we see as the likely consequences.

First of all, it is important to note that (even now) the possibility of Spain or Greece exiting the euro remains slight. This is because:

1. Article 50 of the Eurozone treaty implies that a country cannot exit the Eurozone without leaving the European Union.
This would be to undo almost 70 years of closer European integration, and a total collapse of the existing economic/political order on the continent. For most politicians, this is unthinkable.

2. The cost (both bureaucratic and actual) of leaving the euro remains prohibitive, even in cash-strapped countries such as Greece and Spain.

Imagine the millions of contracts and business arrangements presently denominated in euros, that would need to be recalculated in pesetas. Imagine the thousands of products and services that would need re-pricing. The political cost aside, the bureaucratic task of returning to the peseta would be enormous.

But what if Spain left the euro anyway?

On the other hand, bookies William Hill are offering 5/2 odds on one country leaving the euro in 2012, while the extremist parties forming government in Greece might resurrect the drachma regardless of the consequences. What would we look forward to if Spain did the same?

1. The relaunched peseta would immediately lose 40-60% of its value against the euro.

This would reflect that Spain would only leave the euro if it were in dire economic circumstances. This would immediately make importing products into Spain more expensive, sending the cost of everyday items soaring, and encouraging businesses to sack employees to reduce costs. The domestic economy would enter depression, in other words.

2. Spanish exports would benefit greatly, as would the tourism industry.

Of course, the flip-side to the devalued peseta is that buying Spanish goods and visiting Spain would become much cheaper. This would benefit the Spanish wine industry for instance, while ensuring that Spain’s hotels were full of foreign visitors. If the Spanish government were to re-adopt the peseta, the hope would be that the pick-up in foreign demand would compensate for the domestic slouch, and so drive growth.

3. People would rush to withdraw their euros from their Spanish bank accounts, prior to the change.

This is perhaps the most prohibitive reason a return to the peseta cannot happen. At the merest hint of abandoning the euro, people would rush to their bank accounts and withdraw everything, to avoid being stuck with a currency 40-60% less valuable. The ensuing panic would collapse the Spanish banking system, having a knock-on effect across all of Europe. In the worst-case scenario, this could trigger a crisis bigger than the collapse of Lehman Brothers.

For my money then, the only solution to Spain problem is “more Europe.” The political, bureaucratic, and potential human cost of abandoning the euro make the idea all but unthinkable, forcing Spain (and the rest of Europe) to continue with the integration project they have begun. For us, I think that means the euro is here to stay.

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